mergers and acquisitions

China Merchants Steams in to Compete with SoftBank’s Vision Fund — Financial Times

 

China Merchants Group has been adopting new technology to resist foreign competitors for nearly 150 years. Founded in the 19th century, the company brought steam shipping to China so it could compete with western traders.

Now an arm of the Chinese state, CMG has been enlisted once again to buy up technology at a time when global private equity is vying for a share of China’s burgeoning tech market.

The country’s largest and oldest state-owned enterprise, CMG said this month it would partner with a London-based firm to raise a Rmb100bn ($15bn) fund mainly focused on investing in Chinese start-ups.

The China New Era Technology Fund will be launched into direct competition with the likes of SoftBank’s $100bn Vision Fund, as well as other huge investment vehicles raised by top global private equity houses such as Sequoia Capital, Carlyle, KKR and Hillhouse Capital Management.

“They have been very important to China in the past, especially in reform,” said Li Wei, a professor of economics at Cheung Kong Graduate School of Business in Beijing. “But you haven’t heard much about them in technology . . . It’s not too surprising to see them moving into this area, upgrading themselves once again.”

CMG is already one of the world’s largest investors. Since the start of 2015 its investment arm China Merchants Capital, which will oversee the New Era fund, has launched 31 funds aiming to raise a combined total of at least $52bn, according to publicly disclosed information.

But experts say little is known about the returns of those funds, most of which have been launched in co-operation with other local governments or state companies.

Before New Era, China Merchants Capital’s largest fund was a Rmb60bn vehicle launched with China Construction Bank in 2016. While almost no information is available on its investment activity, the fund said it would focus on high-tech, manufacturing and medical tech.

CMG’s experience investing directly into Chinese tech groups is limited, although it has taken part in the fundraising of several high-profile companies. In 2015 China Merchants Bank joined Apple, Tencent and Ant Financial to invest a combined $2.5bn into ride-hailing service Didi Chuxing, a company that now touts an $80bn valuation. It also invested in ecommerce logistics provider SF Express in 2013.

Success in Chinese tech investing is set to become increasingly difficult as more capital pours into the sector.

“Fifteen billion dollars can seem like a droplet in China,” said Peter Fuhrman, chairman and chief executive of tech-focused investment banking group China First Capital, based in Shenzhen. “We’re all bobbing in an ocean of risk capital. Still, one can’t but wonder, given the quite so-so cash returns from China high-tech investing, if all this money will find investable opportunities, and if there weren’t more productive uses for at least some of all this bounty.”

CMG, however, has always set itself apart from the rest of the country’s state groups. It is unlike any other company under the control of the Chinese government as it was founded before the Chinese Communist party and is based in Hong Kong, outside mainland China. Recommended Banks China Merchants Bank accused of US discrimination

The business was launched in 1872 as China Merchants Steam Navigation Company, a logistics and shipping joint-stock company formed between Chinese merchants based in China’s bustling port cities and the Qing dynasty court.

Mirroring its New Era fund today, it was designed to compete for technology with foreign rivals. At that time it was focused on obtaining steam transport technology to “counter the inroads of western steam shipping in Chinese coastal trade”, according to research by University of Queensland professor Chi-Kong Lai.

Nearly a century later, after falling under the control of the Chinese government, CMG became the single most important company in the early development of the city of Shenzhen, China’s so-called “window to the world” as it opened to the west.

Then led by former intelligence officer and guerrilla soldier Yuan Geng, the company used its base in Hong Kong to attract some of the first investors from the British-controlled city into the small Chinese town of Shenzhen, which has since grown into one of the world’s largest manufacturing hubs.

Its work in opening China to global investment gained CMG and Yuan, who led the company until the early 1990s, status as leading figures in the country’s reform era.

Today the company is a sprawling state conglomerate with $1.1tn in assets and holdings in real estate, ports, shipping, banking, asset management, toll roads and even healthcare. The company has 46 ports in 18 countries, according to the state-run People’s Daily, with deals last year in the sector including the controversial takeover of the Hambantota terminal in Sri Lanka and the $924m acquisition of Brazilian operator TCP Participações.

CMG did not respond to requests for comment. But one person who has advised it on overseas investments said the Chinese government was using it in the same way the company opened up Shenzhen to the outside world, helping “unlock foreign markets”.

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In Today’s China, Paradoxes Still Abound. But So Do Opportunities — Site Selection Magazine

 

In September, China First Capital Chairman and CEO Peter Fuhrman, familiar to attendees at the World Forum for FDI in Shanghai last year, delivered a talk from China to Harvard Business School alumni. Here, with Mr. Fuhrman’s permission, we present excerpts from his remarks.

————–

GDP growth has never and will never absolutely correlate with investment returns.

Any questions? No? Great. Thanks for your time.

Of course I’m joking. But that key reality of successful investing is all too often overlooked, and China has provided all of us over these last 30-some-odd years with a vivid reminder that IRR and GDP are by no means the same animal.

China is, was and will likely long remain a phenomenal economy. The growth that’s taken place here since I first set foot in China in 1981 has been something almost beyond human reckoning. Since I first came to China as a postgrad in 1981, per-capita GDP (PPP) has risen 43X, from $352 to $15,417. China achieved so much more than anyone dare hope, a billion people lifted out of poverty, freed to pursue their dreams, to make and spend a bundle.

China this year will add about $1 trillion of new GDP. Just to put that in context, $1 trillion is not a lot less than the entire GDP of Russia. So who is making all this newly minted money? And how can any of us hope to get a piece of it? Another question: Why, if China is such a great economy, has it proved such a disaster area for so many of the world’s largest, most sophisticated global institutional investors, private equity firms and Fortune 500s?

Turning Inward

Let’s start with the fact that China is a part of the World Trade Organization, but not entirely of it — not fully subscribed in any way to the notion that reciprocity, openness, free trade, level playing fields and equal treatment are positive ends unto themselves. As China has gotten richer it has seen even less and less need to attract foreign capital and foreign investment. That’s a tendency we see in other countries, including obviously some of the rhetoric we now hear in the U.S. — that more of the gains of the national economy should belong to its citizens. But China’s way is different.

The renminbi is a closed non-tradable currency, so getting US dollars into and out of China has always been difficult. China now has the world’s second-largest stock and bond markets, but those markets are largely closed to any investors other than Chinese domestic ones. But China also continues to provide companies going public with by far the highest multiples anywhere in the world.

When I first came to China 36 years ago China was a 100-percent state-owned economy. Twenty years ago the first rules were put in place to allow a private sector to function. Today, according to anyone’s best estimate, it’s about 70 percent private and 30 percent state, and most of the value creation is being provided by that private-sector economy. So in theory there should be very interesting M&A opportunities. But it’s been exceedingly difficult to get successful transactions done. One of the core reasons is that by and large all private-sector companies in China, large and small, are family-owned.

The other thing important to consider is a Mandarin term: guifan. It’s the Chinese way of explaining the extent to which a company in China is abiding by all the rules of the road — the taxes you should pay, the environmental and labor laws you should follow. It’s not at all uncommon that successful private-sector companies in China are successful by virtue of having negotiated to pay little or no corporate tax on profits.

For foreign-owned companies in China it’s an entirely different story. They are by and large 100-percent compliant with the written rules. This has an enormous impact on the operating performance of any company, so you can imagine how potentially skewed the competitive environment becomes. And keep in mind that corporate taxation in China in the aggregate is, if not the highest in the developed world, then among the highest, and the environmental and labor laws are every bit as difficult, rigorous, tough and expensive to implement as they are in the U.S.

China is a country where local government officials are scored on the measurable success of their time in office, and success is overwhelmingly attributed to GDP growth. So it should be no surprise if what they’re trying to do is optimize GDP growth, the percentage of a company’s income that goes back to the government in taxation can have an adverse effect on that. Instead the government will continue to urge its local companies to take the money and, rather than pay tax, continue to invest, expand and therefore build local GDP.

The Hum of Consumerism

The reasons to stay engaged and find a viable investment angle include GDP growth. China’s GDP is likely to continue to grow by at least 6 percent a year. Second, across my 25 years of involvement in China, every one of the predictions of imminent collapse — financial catastrophe, local government debt, bad bank loans, real estate bubbles — have proved to be false. It appears China has some resiliency, and it’s certainly the case that the government has the tools and financial resources to ride out most challenges.

Third has been how effortlessly it’s made the transition that still bedevils lots of Europe, from a smokestack economy to a consumer-spending paradise. At this moment every major consumer market in China is booming both online and offline. Alibaba, Baidu and Tencent are now operating as three of the most profitable companies in the world.

How does China have a robust, booming consumer economy and an enormous appetite for luxury brands, yet on average salary levels that are still one-fifth or one-sixth the levels in the US? The simple answer is that almost all the Chinese now living in urban China — about half the population, compared to about 15 percent when I first got here — owns at least a single apartment if not multiple, which is more and more common. The single best-performing asset in history has probably been Chinese urban real estate over the last 30 years. It’s fair to say the average appreciation over the last 10 years is at least 300 percent.

Though China has a population whose incomes on paper look like those of people flipping burgers at McDonald’s, they seem to have the spending power and love of luxury goods like the people summering in East Hampton. Even Apple itself has no idea how big its market is here in China. It’s likely that at least 100 million iPhone 8s will be sold to Chinese over the next year. The retail price here in China is at least 30 to 40 percent higher than in the US, with most phones bought for cash, without a carrier subsidy.

‘You’ll Be Older Too’

So where is it possible to make money in China? One message above all: Active investing beats passive investing every time. What you need to do is either be the owner-operator or be a close strategic partner with one, and stay actively engaged.

There are four major areas of opportunity: Tech, health-care services, leisure and education (see graphic below). The potential for building out a chronic care business in China is enormous. Looking ahead 25 to 30 years, sadly China will likely suffer a demographic disaster. This country will become a very old society very quickly. That’s the inevitable product of 30 years of a one-child-per-family policy. By 2040 or 2050, 25 percent of China will be over the age of 65.

The overall rate of GDP growth is unlikely to ever rival that of a few years ago at 10 to 12 percent a year, but overall what we have is higher-quality growth. People in China are living well. Things should continue to motor along very smoothly at least for one more generation — a generation whose members are better educated, more skilled, ambitious and globalized than their parents.

There’s no denying the reality of what a better, happier, freer, richer country China has become since I first set foot here. I marvel every day at the China that I now live in, even while I occasionally curse some of the unwanted byproducts like heavy pollution in most parts of the country, overcrowding at tourist attractions, bad traffic, and a pushy culture that’s lost touch with some of China’s ancient glories.

China will continue to amaze, inspire and stupefy the world. The Chinese have done very well and will do better. At the same time, those of us investing in China may do a little better in years to come than we have up to now. More of the newly minted trillions in China just may end up sticking to our palms.

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China’s Soccer Push Puts a Storied Team Under Murky Ownership — The New York Times

 

By SUI-LEE WEE, RYAN McMORROW and TARIQ PANJA

NOV. 16,    2017

Li Yonghong in April with David Han Li, left, of Rossoneri Sport Investment, part of A.C. Milan’s new ownership group, and Marco Fassone, the club’s chief executive.

BEIJING — When the Chinese businessman Li Yonghong bought A.C. Milan, the world-famous Italian soccer club, virtually nobody in Italy had heard of him.

Virtually nobody in China had, either.

Mr. Li had never been named to one of China’s lists of the country’s richest people. The mining empire he described to Italian soccer officials was hardly known even in mining circles.

Nevertheless, Mr. Li seemed to have what mattered most: money. He bought the club in April for $860 million from Silvio Berlusconi, the former Italian prime minister, to clinch China’s biggest-ever soccer deal.

Today, Mr. Li’s acquisition of A.C. Milan appears to be emblematic of a string of troubled Chinese deals.

The soccer club, bleeding money after a spending spree on star players, is seeking new investors or a refinancing of the high-interest loan that Mr. Li took to buy the club. That loan comes due in a year.

Chinese corporate records show that — on paper, at least — someone else owns his mining empire. That company’s offices were empty on a recent visit, and a sign on the door from the landlord cited unpaid rent. A spokesman for A.C. Milan said Mr. Li’s control of the mining business had been verified by lawyers and banks involved in the transaction.

Chinese records also show a series of business disputes and run-ins between Mr. Li and Chinese regulators.

China’s emergence as a world economic power came with a ready checkbook for major brand names. Chinese owners now control the Waldorf Astoria hotel in New York, AMC theaters, the Hollywood production company Legendary Entertainment and A.C. Milan.

Then Chinese officials began to worry that the spending was simply part of an exodus of money from China so vast that it once threatened to destabilize the country’s economy, the world’s second largest. This summer, the government ordered its banks to scrutinize lending to some of the country’s biggest deal makers.

Outside China, some of the deals led regulators to ask questions about the tycoons behind them. Some wealthy people in China list their holdings under the names of relatives or associates to avoid scrutiny, a practice that has attracted criticism inside and outside the country.

In the case of Mr. Li, the mines that he told A.C. Milan he controlled have been owned by four different people since last year, according to Chinese corporate records. The business changed hands twice for no money, the documents show.

Mr. Li declined an interview request through A.C. Milan. The club spokesman defended Mr. Li on his business disputes, saying that sometimes he was a victim and that sometimes he was not aware of complicated rules. The spokesman also said the club was evaluating several refinancing proposals and was confident it could cover the loan.

Chinese spending on soccer totaled $1.8 billion over the past five years, according to Dealogic, a data provider, but Chinese officials are putting a stop to the spree amid concerns about the flight of money abroad.

“There’s a lot of ways to invest in football and the sports industry for much less money,” said Mark Dreyer, who tracks Chinese soccer investments on his website, China Sports Insider. “People were basically using the government’s previous push for sports as a way to diversify into different industries and get their money out of China.”

Mr. Li had plenty of reasons to buy A.C. Milan. President Xi Jinping had professed his love for soccer and wanted China to be a superpower in the sport by 2050. The Chinese government had laid out a plan for increasing sports investment.

An acquisition of A.C. Milan would be a marquee deal. A decade ago, the club was home to some of soccer’s biggest talents, including Ricardo Izecson dos Santos Leite, who is known as Kaká, and Andrea Pirlo. It was a seven-time European champion.

But it has not won an Italian championship for six years or a European title for 10. Fans welcomed Mr. Li’s arrival as a potential catalyst. This summer, A.C. Milan began to spend on new players in a way that seemed to signal a desire to compete again.

Still, Mr. Li and Mr. Berlusconi struck the deal at a difficult time. Beijing, spooked by the unprecedented capital outflows and a weakening currency, had imposed restrictions on overseas investment at the end of last year.

Mr. Li set up companies in the British Virgin Islands and Luxembourg that would put the club’s legal ownership outside China, according to Marco Fassone, A.C. Milan’s chief executive officer. Mr. Li also borrowed about $354 million from the hedge fund firm Elliott Management, a loan he must pay back by October 2018. A spokeswoman for Elliott declined to comment.

A.C. Milan remains debt laden and unprofitable, and could have trouble repaying what it owes on its own. It spent about $274 million to sign 11 players this summer, according to the club spokesman, making it among the biggest spenders in European soccer.

In August, A.C. Milan had to wait for the transfer of two players it had signed from other teams because it had not deposited the required bank bonds. The club blamed a timing issue for the delay, and the transfers were eventually completed. The team is in seventh place but, with more than two-thirds of the season left to play, must finish among the top four to earn a spot in European soccer’s elite Champions League next season. The team could lose valuable television revenue if it fails to reach that level.

It is unclear how much Mr. Li’s wealth might help the club address its troubles.

He was initially unknown to the deal makers trying to sell the club, the people involved in the transaction said. He was originally part of a group that included Sonny Wu, a well-known investor who is chairman of the private equity firm GSR Capital, these people said. But Mr. Wu pulled out of the deal.

In an email, Mr. Wu said he had not talked to bankers about Mr. Li or his consortium. Rothschild & Company, the investment bank that advised Mr. Li, declined to comment.

Mr. Li told A.C. Milan that his holdings included phosphate mining operations in the city of Fuquan in Guizhou Province.

But Chinese corporate filings show that the mines are owned by another party: Guangdong Lion Asset Management, an investment company. And Guangdong Lion has had a complicated ownership record over the past two years, involving a number of people with similar family names. (One court proceeding suggests Mr. Li has a relationship with Guangdong Lion, although it is not clear what kind.)

Originally, Guangdong Lion was ultimately owned by two investors, Li Shangbing and Li Shangsong, according to filings. Like Li Yonghong, the two men come from the same area of Maoming, a city on China’s southern coast, according to the documents. But in a phone interview, Li Shangbing said he did not know Li Yonghong.

Li Shangsong, who declined to comment, sold his interest in Guangdong Lion in 2015 to a person named Li Qianru, according to the documents. The documents did not include personal information about Li Qianru, who could not be reached for comment.

In May 2016, according to the filings, Li Shangbing and Li Qianru, sold Guangdong Lion to yet another Li: Li Yalu. The sale price: $0. The filings do not provide personal information about Li Yalu.

Three weeks later, Li Yalu sold a half stake in Guangdong Lion to a similarly obscure investor, Zhang Zhiling. The price: $0. Neither could be reached for comment.

Li is a common surname in China, and the relationships among the various Lis are unclear. The A.C. Milan spokesman declined to comment.

Li Yonghong, the A.C. Milan owner, and Li Shangbing have two things in common.

The first is a relationship with Guangdong Lion. A Chinese court cited Li Yonghong and Guangdong Lion in April for failing to resolve a loan dispute with another Chinese company, saying both parties had disappeared. The court did not specify the relationship. The A.C. Milan spokesman said that Li Yonghong had merely guaranteed the loan and that “he is a victim in this case.”

The second is an interest in investing in European sports.

In May 2016, a day before Li Shangbing sold Guangdong Lion for no money, he started a company called Sino-Europe Sports Asset Management Changxing Company, according to China’s corporate database.

Two days after he registered the Sino-Europe firm, another person registered a new company with a strikingly similar name: Sino-Europe Sports Investment Management Changxing Company. The two companies’ headquarters were in the same building in the city of Huzhou.

Sino-Europe Sports Investment owns a stake in A.C. Milan as a result of its role as a shareholder in Rossoneri Sport Investment, a Chinese company that is part of the group led by Li Yonghong that owns the soccer club.

In the phone interview, Li Shangbing denied setting up either Sino-Europe company and said he did not own any part of A.C. Milan. He declined to answer further questions. A.C. Milan declined to comment on Li Shangbing. The listed owner of the Sino-Europe Sports Investment Management Changxing Company, Chen Huashan, could not be reached for comment.

Guangdong Lion’s listed headquarters are in a fancy skyscraper in Guangzhou. In August, the offices were closed, with an eviction notice on the door. Inside, desks and chairs were in disarray, computers were missing hard drives, and maggots festered in a trash can.

The phone number listed for Guangdong Lion connects to a woman who said she helped companies register with Chinese regulators.

Li Yonghong has an extensive business history, but Chinese records show it includes disputes with regulators and others.

In 2013, China’s securities watchdog fined Mr. Li $90,250 for failing to report the sale of $51.1 million in shares of a real estate company. A.C. Milan said Mr. Li had simply been unfamiliar with listing rules.

In 2011, that same real estate company said in a stock filing that Mr. Li was the chairman of Grand Dragon International Holding Company, a Chinese aviation company. Grand Dragon said in June that he had no present or past association with the company. The A.C. Milan spokesman said he had no knowledge of this.

In 2004, Mr. Li’s family business, the Guangdong Green River Company, teamed up with two other companies to bilk more than 5,000 investors out of as much as $68.3 million, according to The Shanghai Securities News, the official newspaper of China’s financial watchdogs. They had sold contracts for lychee and longan orchards and promised investors hefty returns, according to the report.

Mr. Li’s father and brother were sentenced to jail. Mr. Li was investigated but not accused of wrongdoing, the report said.

A.C. Milan said the episode had nothing to do with Mr. Li, adding that “he was not aware of the situation until the investigation.”

Amid Chinese concerns about deals abroad, China’s purchases of soccer teams with prestige names is likely to slow considerably for some time to come.

“If outbound investment should have the purpose of ‘strengthening the nation,’ even within the broadest of definitions,” Peter Fuhrman, chairman of the investment bank China First Capital, said in an email, “buying a soccer team in the U.K. or Italy would hardly seem to qualify.”

As published in The New York Times

Why Has China’s GDP So Outpaced IRR?

It’s the paradox at the core of China investing: why has such a phenomenal economy proved such a disappointing investment destination for so many global institutional investors, PE firms and Fortune 500s.

Financial theory provides a conceptual explanation. Investment returns are not absolutely correlated to GDP growth. China will likely go down in history as the best proof of this theorem. China as certainly delivered exceptional GDP growth. In per capita PPP terms, China is 43 times larger than in 1981, when I first set foot in China as a grad student. No other country has ever grown so fast, for so long and lifted so many people out of poverty and into the consumer middle class.

Commensurate investment returns, however, have been far harder to lock in. Harvard Business School’s global alumni organization invited me to give an hour-long talk on this topic this week. It required a quick gallop through some recent and not always happy history to arrive at the key question — does the future hold m0re promise for global institutional investors looking to deploy capital in China.

 For more detailed look at some reasons for the big disconnect between China’s national GPD growth and investment IRR, and some suggestions how to improve matters, please have a look by clicking here at the HBS talk slide deck.

Publicly-quoted shares in Chinese companies have failed by far and away to keep pace with the growth in overall national income. In the alternative investment arena, global PE and VC firms enjoyed some huge early success in late 1990s and first part of the 2000s. Since then, the situation has worsened, as measured in cash returns paid out to Limited Partners. One major reason — the explosion within China of Renminbi investment funds, now numbering at least 1,000. They’ve bid up valuations, gotten first access to better opportunities, and left the major global PE and VC firms often sitting on the sidelines. With tens of billions in dry powder, these global firms look more and more like deposed financial royalty — rich, nostalgic, melancholy and idle.

China this year will add approximately $1 trillion of new gdp this year – that’s not a lot less than the entire gdp of Russia. Indeed, China gdp growth in 2017 is larger than the entire gdp of all but 15 countries. Who is making all this money? Are all the spoils reserved for local investors and entrepreneurs? Can global investors find a way at last to get a bigger piece of all this new wealth?

Overall, I’m moderately sanguine that lessons have been learned, especially about the large risks of following the Renminbi fund herd into what are meant to be sure-thing “Pre-Ipo” minority deals. Active investment strategies have generally done better. With China’s economy well along in its high-speed transition away from smokestack industries and OEM exports to one powered by consumer spending, there are new, larger and ripe opportunities for global investors. In virtually all major, growing categories of consumer spending, Western brands are doing well, and will likely do better, as Chinese consumers preferences move upmarket to embrace high-quality, well-established global household brand names.

Harvard, its alumni and benefactors have a two hundred year history of investing and operating in China. So, there’s some deep institutional memory and fascination, not least with the risks and moral quandaries that come with the territory. The Cabot family, at one time among America’s richest, provided huge grants to Harvard funded in part by profits made opium running into China.

Harvard Management Company, the university’s $35 billion endowment, was an early and enthusiastic LP investor in China as well as large investor in Chinese quoted companies including Sinopec. Their enthusiasm seems to be waning. Harvard Management is apparently considering selling off many of its LP positions, including those in PE and VC funds investing in China.

This looks to be an acknowledgment that the GP/LP model of China investing has not regularly delivered the kind of risk-adjusted cash-on-cash returns sophisticated, diversified institutional investors demand. While China’s economy is doing great, it’s never been harder to achieve a successful private equity or venture capital investment exit. True, the number of Chinese IPOs has ratcheted up this year, but there are still thousands of unexited deals, especially inside upstart Renminbi funds.

While decent returns on committed capital have been scarce, the Chinese government continues to pour billions of Renminbi into establishing new funds in China. There’s hardly a government department, at local, provincial or national level that isn’t now in the fund creation business. Diversification isn’t a priority. Instead, two investment themes all but monopolize the Chinese government’s time and money — one is to stimulate startups and high-tech industry (with a special focus on voguish sectors like Big Data, robotics, artificial intelligence, biotech) the other is to support the country’s major geostrategic initiative, the One Belt One Road policy.

One would need to be visionary, reckless or brave to add one’s own money to this cash tsunami. Never before has so much government money poured into private equity and venture capital, mainly not in search of returns, but to further policy and employment aims. It’s a first in financial history. The distortions are profound. Valuations and deal activity are high, while returns in the aggregate from China investing will likely plummet, from already rather low levels.

Where should a disciplined investor seek opportunity in China? First, as always, one should follow the money — not all the government capital, but the even larger pools of cash being spent by Chinese consumers.

In China, every major consumer market is in play, and growing fast. This plays to the strengths of foreign capital and foreign operating companies. There are almost unlimited opportunities to bring new and better consumer products and services to China. Let the Chinese government focus on investing in China’s future. High-tech companies in China, ones with globally competitive technology, market share and margins are still extraordinarily rare, as are cash gains from investing here.

Meantime, as I reminded the HBS alumni, plenty of foreign companies and investors are doing well today in China’s consumer market. Not just the well-known ones like Apple and Starbucks. Smaller ventures helping Chinese spend money while traveling globally, or obtain better-quality health care and education options, are building defendable, high-margin niches in China. One company started by an HBS alumnus, a native New Yorker like me, is among the leading non-bank small lending companies in China. It provides small loans to small-scale entrepreneurs, mainly in the consumer market. Few in China know much about Zhongan Credit, and fewer still that it’s started and run by a Caucasian American HBS grad. But, it’s among the most impressive success stories of foreign investment in China.

Of course, such success investing in China is far from guaranteed. Consumer markets in China are tricky, fast-changing, and sometimes skewed to disadvantage foreign investors. For over two hundred years, most foreign investors have seen their fond dreams of a big China payday crash on the rocks of Chinese reality.

The rewards from China’s 35 years of remarkable economic growth has mainly — and rightly — gone to the hard-working people of China. But, there’s reason to believe that in the future, more of the new wealth created each year in China will be captured by smart, pragmatic investors from HBS and elsewhere.

 

As published by China Money Network

As published by SuperReturn

YouTube video of the full lecture to Harvard Business School alumni organization

 

 

 

China Steps Up Warnings Over Debt-Fueled Overseas Acquisitions — The New York Times

BEIJING — China moved on Friday to curb investment overseas by its companies and conglomerates, issuing its strongest signal yet that it wants to rein in runaway debt that could pose a threat to the country’s slowing economy.

Beijing has stepped up its efforts in recent months to restrict some of its most acquisitive companies from buying overseas assets, worried that a series of purchases by China’s conglomerates around the world has been driven by excessive borrowing.

In the latest move, a statement published by China’s cabinet, the State Council, said the authorities would punish companies for violating foreign investment rules, and establish a blacklist of businesses that did so. The statement was attributed to the National Development and Reform Commission, the commerce ministry, the foreign ministry and the central bank.

The statement pointed to acquisitions in sectors ranging from entertainment and sports clubs to hotels, but it was unclear whether or how the government would block deals.

It reiterated a warning issued in December that restrictions on overseas investments were being imposed because of “irrational” investment trends.

That statement said that the kinds of investments overseas it described were “not in accordance with macro-control policies.” The government wants to “effectively guard against all sorts of risks,” it said. The State Council document said the government nevertheless supported overseas investments in sectors such as oil and gas and in China’s “One Belt, One Road” program, which aims to promote infrastructure projects along the historic Silk Road trading route.

“It’s the loudest yet of wake-up calls that the government holds the keys to the lockbox of the country’s wealth, public and private,” Peter Fuhrman, chairman of China First Capital, an investment bank, said in an emailed response to questions. “Bad M&A is all but criminalized.”

A surge in overseas acquisitions by Chinese investors in recent years has ignited fears that soaring corporate debt levels could destabilize the country’s economy, the world’s second largest, and further weaken its currency.

Companies like Anbang Insurance Group, Fosun International, the HNA Group and Dalian Wanda Group have capitalized on cheap loans provided by state banks to snap up trophy assets such as the Waldorf Astoria hotel in New York and AMC Theaters.

Beijing’s clampdown on overseas investments shows how the interests of private business can collide with those of the Communist Party government. Beijing has made financial stability a priority this year, with the party’s congress scheduled in the fall. Among the party’s top concerns: controlling debt, stemming the flow of capital leaving the country, and China’s opaque “shadow banking” system.

But while the latest statement from the State Council is likely to have an impact on mergers and deals, a lot of Chinese money is already offshore and thus not easily restricted by the government in Beijing, said Alexander Jarvis, chairman of Blackbridge Cross Borders, which has advised Chinese companies on several soccer acquisitions.

“Deals are still going to happen,” Mr. Jarvis said. “There is plenty of Chinese capital overseas in offshore tax havens, in the U.S., across Europe, Hong Kong. I’m not sure they can fully control that capital.”

In a sign of that deal making, a Chinese businessman, Gao Jisheng, struck a deal to buy an 80 percent stake in Southampton Football Club, a soccer team in the English Premier League, for about $271 million. Mr. Gao obtained the loan from a bank in Hong Kong, a special administrative region of China that is administered under separate laws, Bloomberg reported on Thursday.

Geoffrey Sant, a partner at New York-based law firm Dorsey and Whitney, said it is likely that the latest announcement from Beijing will result in a “temporary pause” in overseas acquisitions.

“I think they are thinking there’s a bit of irrational exuberance in the market right now and they just want to cool that off,” said Mr. Sant, who represents Chinese companies. “It doesn’t make sense to permanently ban some of these areas.”

The State Council statement comes amid increased scrutiny of China’s “gray rhinos” — threats that are large and obvious but often neglected even so.

In recent months, the government has said it would increase scrutiny of companies’ balance sheets, warning that some of the largest companies could pose a systemic risk to the economy.

Encouraged by the slew of acquisitions made by some of the country’s most powerful tycoons, many smaller Chinese companies started looking overseas, spurred by China’s slowing economic growth to look for new markets.

Many, however, had no experience running the businesses they were targeting. In one such example, Anhui Xinke New Materials, a copper processing company in central China, made a deal to buy Voltage Pictures, an American film financing and production firm, for $350 million. A month later, Anhui Xinke pulled out of the transaction.

In other cases, it was not clear whether many of the big trophy acquisitions were actually good deals.

In 2015, Legendary chalked up a net loss of $540 million, according to a regulatory filing that Wanda Film filed on the Shenzhen Stock Exchange. Fosun International, meanwhile, paid a premium to buy French resort operator Club Med, which was until then an unprofitable company, eventually agreeing to a $1.1 billion price tag in 2015 after a long takeover battle. The firm made a small profit last year, according to Fosun’s filings. And last year, AC Milan, the Italian soccer club that was acquired by a Chinese consortium for about $870 million, made a net loss of about $88 million.

“I agree with the Chinese government. A lot of these deals are bad,” said Mr. Jarvis.

Companies have already started feeling the pinch of Beijing’s clampdown on overseas investments, which started in earnest in December.

The number of newly announced outbound mergers and acquisitions by Chinese firms fell by 20 percent in the first six months of 2017 compared to the same period in 2016, though it picked up in May and June, according to Rhodium Group, a New York-based research firm.

In March, Dalian Wanda, the Chinese conglomerate that owns AMC Theaters and Legendary Entertainment, was forced to abandon its $1 billion deal to buy Dick Clark Productions, the firm behind the Golden Globes and Miss Universe telecast after Beijing tightened its controls on capital outflows. Months later, Wanda sold a majority stake in 13 theme parks to property firm Sunac China Holdings and handed 77 hotels to R&F Properties, another real estate company based in the southern city of Guangzhou, for $9.5 billion.

As published in The New York Times.

The New York Times Interview Transcript

After Wanda Deal, Chinese Property Developer Faces Debt Risk — The New York Times

A Dalian Wanda property in Nanchang, China.

BEIJING — The Chinese property developer Sunac China Holdings has turned into one of the country’s biggest white knights, swooping in to help troubled companies with too much debt. The risk: Sunac is amassing its own large pile of debt in the process.

Sunac has more than doubled its debt load in a year to $38 billion. Its deal this week to buy a portfolio of theme parks and hotels from the Dalian Wanda Group, the heavily indebted Chinese conglomerate, will add to the tab. At $9.3 billion, the acquisition is larger than the market value of Sunac.

“The problem for Sunac is twofold,” said Peter Fuhrman, chairman of China First Capital, an investment bank. “They themselves are already rather overleveraged and they are not paying distressed prices.”

Sunac is offering a much-needed lifeline.

For years, China fueled growth by providing easy credit. Chinese companies borrowed heavily, using the money to fund aggressive expansions.

As the economy now slows, companies are increasingly running into financial trouble, with some having to borrow even more to pay their debts. Policy makers are worried that the country’s Passover level of corporate debt could threaten the broader financial system.

Sunac, China’s seventh-largest property developer in terms of sales, has been able to tap into its financial strength to help companies under pressure. Since 2012, Sunac’s property sales have grown at double-digit rates nearly every year, giving it the firepower to scoop up assets and land plots.

Before the Wanda deal, Sunac in January pumped $2.2 billion into LeEco, a tech firm struggling to pay off its creditors. This May, it paid $1.5 billion for an 80 percent stake in Tianjin Xingyao, a property firm known for leaving its projects uncompleted.

In 2015, Sunac made a play to rescue Kaisa, pledging $1.2 billion to take over the troubled property company; it later pulled out after Kaisa did not meet certain conditions for the deal. That same year, it announced a partnership with the cash-poor Yurun Holding Group, which ran a business empire ranging from sausage making to property and finance.

It is a remarkable turnabout for the company’s founder, Sun Hongbin.

Mr. Sun started his career at the Lenovo Group, where he was promoted to run enterprise development. But he had a falling out with Liu Chuanzhi, the founder of Lenovo, over a business dispute. Related to the dispute, Mr. Sun was sentenced in 1992 to five years in jail for misappropriation of public funds.

After his release in 1994, he met with the founder of Lenovo and apologized, according to the website of The People’s Daily, the ruling Communist Party’s official newspaper. The Lenovo founder eventually lent Mr. Sun about $74,000, which he used to start a predecessor real estate firm to Sunac.

Lenovo did not immediately respond to a request for comment.

When Mr. Sun started Sunac in 2003, he focused on the cities of Wuxi and Chongqing and then moved on to China’s most developed cities, among them Beijing, Shanghai, Tianjin and Hangzhou, building apartments with names like Beijing Fontainebleau Chateau. Sunac built its residential projects in good locations near city centers and was aggressive in acquiring land plots — with higher debt.

 Sun Hongbin, the founder and chairman of Sunac China Holdings.

“People who have failed are those who have been defeated by themselves,” Mr. Sun told a newspaper, China Business News, in 2013. “But I often tell others: After you fail, you can start again.”

With the Wanda deal, Sunac is extending its reach into tourism, paying $9.3 billion for 76 hotels and a major chunk of its 13 tourism projects, in the country’s largest property acquisition ever. The purchase will help Sunac diversify its business, which is hurting from government restrictions on home sales as Beijing seeks to cool a frothy property market. It also strengthens the company’s hand in an industry dominated by bigwigs like the China Vanke Group and Country Garden.

“Within the housing industry, the powerhouses are really strong,” said Lu Wenxi, an analyst for Centaline Properties who is based in Shanghai. “If you don’t gobble up the fat ones, it is easy to be eaten up by others. Taking on more projects will prevent you from being eaten.”

Investors have rewarded Sunac for the deal. Shares of Sunac rose 14 percent in Hong Kong on Tuesday after they resumed trading after the deal announcement.

But the deal will add to an already significant debt load. In 2016, the company’s net gearing ratio — a measure of total debt to shareholders’ equity — rose to 121.5 percent, from to 75.9 percent in 2015. Fitch Ratings recently downgraded the company’s credit rating to BB-, saying Sunac’s acquisitive approach had made its financial profile “more volatile.”

Wanda is helping finance the acquisition. Sunac, in a statement to the Hong Kong Stock Exchange on Monday, said Wanda would procure a loan for the company worth about $4.4 billion.

Seller financing is not uncommon, both in China and the West. But Wanda’s role means that Sunac doesn’t have all the money upfront.

“In my experience, I’ve never seen it anywhere,” said Lester Ross, a Beijing-based partner with the law firm WilmerHale, who has advised deals in China for the last 20 years. “No client that I represent would accept a deal like that where you’re responsible for raising the money to pay for somebody else.”

Sunac did not return multiple calls for comment. The company said in a statement to the Hong Kong Stock Exchange on Tuesday that the deal with Wanda “will add a large number of prime land reserves and property assets for the company at a reasonable cost.”

The LeEco deal is also prompting concern.

Sunac invested $2.2 billion in LeEco, buying minority stakes in three of the conglomerate’s more stable businesses, including the smart TV affiliate Leshi Zhixin, Le Vision Pictures, and Leshi Internet. The two companies don’t have many overlapping interests, and LeEco’s finances have continued to sour. Before the Wanda deal, shares of Sunac were falling on fears that LeEco’s problems would spread.

In a January news conference, Mr. Sun said many people had tried to dissuade him from investing in LeEco, adding that several were “resolutely opposed” to it.

“I seriously considered their views, but I don’t think their opinions are sufficient to change my mind,” he said.

Article as published in the New York Times

China Probe of Big Companies Could Redefine Their Role Overseas — VOA News

China is probing the loan practices of a group of big private sector conglomerates who have been on a high-profile global spending spree over the past few years.And although the review targets only a few of the country’s most politically-connected companies, some analysts see an attempt to increase government control over the role played by the private sector in foreign markets.

“I think this is an attempt to change the direction (of) the role these Chinese companies play in the Chinese economy,” says Paul Gillis, a professor at Peking University’s Guanghua School of Management. “To align them more closely with the policies of the government and to reduce the risks that actions of these private companies could end up having a shock effect on the economy as a whole.”

Chinese authorities say they launched the probe because of worries that highly leveraged overseas deals pose risks to China’s financial system. Officials have already expressed worries over mounting debt among Chinese lenders, some of which may remain hidden by China’s opaque lending networks.

Notable companies targeted

According to media reports, the list of companies under review is a relative who’s who of Chinese enterprises.

Among those reportedly targeted are Dalian Wanda, which owns the AMC Theaters chain in the United States and has been actively courting deals in Hollywood. High-flying insurance company Anbang, which owns New York’s Waldorf Astoria and Essex House hotels. Also on the list is Hainan Airlines, which bought a 25 percent stake in Hilton Hotels last year and another insurance company Fosun, which owns Cirque de Soleil and Club Med.

Over the past few years, China has seen massive amounts of capital moving overseas with companies and wealthy individuals buying assets abroad. Authorities began taking steps late last year to tighten controls. But many big conglomerates view foreign investment as a golden opportunity – given the low global interest rate environment – and worth the risk of highly-leveraged investments.

Peking University’s Gillis says it appears the Chinese government is coming to terms with how to effectively regulate private enterprises, companies that behave more aggressively than their state-owned counterparts. But he also sees the move as a further consolidation of power by President Xi Jinping, bringing companies more under the control of the central government.

“I think many of the companies had a pretty favorable treatment from prior administrations, and I think Xi Jinping is less enamored of these large private companies than some of his predecessors were.”

Expensive acquisitions by companies like Wanda and Anbang have thrust China into the global spotlight. But the news and commentary that followed the companies’ mega-deals has not always been positive.

FILE - People walk past an entrance to the Anbang Insurance Group's offices in Beijing, June 14, 2017.

People walk past an entrance to the Anbang Insurance Group’s offices in Beijing, June 14, 2017.

In some cases, the deals have given China a black eye, says Fraser Howie, author of the Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise. Anbang’s attempt last year to purchase Starwood Hotels is one example, he says.

“This is high profile, global Bloomberg headline, Chinese company buys Starwood Group, next week it’s all off because the funding was never there, the due diligence could never be completed there, it made all Chinese bidders look horrible,” said Howie. “It looks dreadful for the party and for the leadership that these private entrepreneurs are running out there and yet China as a country is being impacted by it.”

Earlier this month, the head of Anbang was the latest to be swept up in the ongoing financial crackdown.

Regulating private spending?

Authorities so far have not said specifically what the targeted companies may have done wrong, if anything. Some analysts argue that the probe is just a part of a process that began six month ago to curtail the flight of capital from China.

“If cross-border M&A deals make sense, if they deliver strong returns, then there should be no problem either for bankers or those doing the buying. But, if Chinese groups overpay and get the money to do so from Chinese banks providing risky or underpriced loans, then Chinese regulators have an obligation to step in,” Peter Fuhrman, Chairman and Chief Executive Officer of China First Capital tells VOA in an emailed response.

Others see a deeper message about Xi Jinping’s view on the role that private companies should serve broader national goals.

Howie says the probe challenges assumptions about the role of private enterprises in China.

“If anyone ever thought these companies were truly private in the sense of being independent or beyond government reach. Clearly that was never true,” he says. “Everyone operates at the discretion of the Communist Party, even if you’ve done nothing wrong and clearly even if you are wealthy.”

 

https://www.voanews.com/a/china-probes-big-comanys-overseas-loan-practices/3913190.html

Turbulence and Paralysis: the Year Ahead in US-China Relations — Financial Times

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A month before his official inauguration, Donald Trump is already tossing diplomatic grenades in China’s direction. It is a sign of things to come. 2017 is shaping up to be a highly eventful, taut and precarious year for China-US relations. This is partly due to a simple scheduling coincidence.

2017 will be the first time ever when both the US and the PRC in the same year will usher in new governments. The US will kick things off on January 20th by swearing in Donald Trump as President. China, meanwhile, will undertake its own large political upheaval, its five-yearly change in political leadership, culminating in the 19th Communist Party Congress sometime late in the year. Virtually the entire government hierarchy, from local mayors on up, will be changed in a monumental job-swapping exercise orchestrated by Xi Jinping, China’s president.

The US under Mr Trump, with a Republican Congress at his back, seems intent to challenge China more assertively in trade, investment and as a currency manipulator while intensifying the military rivalry. China’s leadership, meantime, will become deeply absorbed in its own highly secretive, inward-looking and internecine political maneuvering. While Mr Xi tries to further consolidate his power, Mr Trump will likely be asserting his, leading to a globally ambitious US and an introspective China. This would represent something of a role reversal from recent precedent.

With the chess pieces all in motion, businesses should be plotting their moves in China with caution. The proposed Trans Pacific Partnership (TPP) trade deal is dead, leaving China’s still-evolving “One Belt,One Road” initiative as the main impetus for new trade flows in Asia. Donald Trump says he will push for what he claims to be more “more fair” bilateral trade deals. China, with its $365bn trade surplus with the US and high barriers to much inward investment, is clearly in his sights.

How will China react? The only certainty is that as the year progresses, China’s government apparatus will slow, and with it decision-making at policy-making bodies and many State-owned enterprises (SoEs). All will wait to hear what new tunes to march to, once the new ruling Politburo is revealed to the public in the fourth quarter.

Chinese officials at all levels are already jockeying for promotion. That means falling into line with Mr Xi’s anti-corruption campaign. The Party Secretary in Jiangsu province, one of China’s wealthiest, got an early head start. He instituted his own form of localized prohibition, ordering that government officials could no longer drink alcohol at any time, in any kind of setting, anywhere in Jiangsu.

The booze embargo did include one loophole. If senior foreign guests are present, alcohol can flow as before, like an undammed torrent.

As the Party Congress approaches, it will be even harder to get a deal with a Chinese SoE lined up and closed within any kind of reasonable time frame. Even after the Party Congress ends, it will likely take more months for any real deal momentum to return. Investment banking bonuses along with billings at global law, accounting and consulting firms are all likely to take a hit.

One other certainty: the renminbi will come under increasing pressure as the US ratchets up its moves to apply tariffs to Chinese exports and China’s own economy remains, relatively speaking, in the doldrums. How much pressure, though, is another question.

Anyone making predictions about the speed and degree of the renminbi’s decline is playing with a loaded weapon. A year ago some of the world’s biggest and loudest hedge fund bosses, including Kyle Bass, David Tepper and Bill Ackman, were proclaiming the imminent collapse of the renminbi. The renminbi, despite slipping by about 6 per cent during 2016, has yet to behave as the money guys predicted.

The Chinese government uses non-market mechanisms to slow the renminbi’s decline. A recent example: its abrupt move in November to tightly control outbound investment and M&A. But shoring up the currency will undercut one of China’s larger economic imperatives, the need to upgrade the country’s industrial and technological base. That will require a prodigious volume of dollars to acquire US and European technology companies such as recent Chinese deals to acquire German robot-maker Kuka and US semiconductor company Omnivision.

Chinese investors and acquirers not only face tighter controls on the outflow of US dollars. The US is also becoming more antagonistic toward Chinese acquisitions in the US and globally. Deals of any significant size need to pass a national security review overseen by a shadowy interagency body known as the Committee on Foreign Investment in the United States, or CFIUS.

CFIUS works in secret. In recent months, it has blocked Chinese investment in everything from a San Diego hotel, to Dutch LED light bulbs as well as US and European companies more explicitly involved in high-tech industry including semiconductor design and manufacturing. The strong likelihood is CFIUS will become even more restrictive once Mr Trump takes over.

Unlike most areas of bilateral tension between the US and China, this is one area where the Chinese have no room to retaliate in kind. China already has a blanket prohibition on investment by US, indeed all foreign companies, into multiple sectors of the Chinese economy, from tech industries like the internet and e-commerce all the way to innocuous ones like movies, cigarettes and steel smelting. So, for now, China quietly seethes as the US intensifies moves to prevent China investment deals from being concluded.

China will probably need to regroup and start playing the long game. That means investing more in earlier stage tech companies, especially in the Silicon Valley, and hoping some then strike it big. These venture capital investments generally fall outside the tightening CFIUS net. China wants to spend big and spend fast, but will find it often impossible to do so.

Even as political and military tensions rise between the US and China in 2017, one ironic certainty will be that a record number of Chinese are likely to go to the US as tourists, home buyers or students and spend ever more there. China’s ardour for all things American – its clean air, high-tech, good universities, relatively cheap housing, and retail therapy – is all but unbounded.

If informal online surveys are to be believed, ordinary Chinese seem to like and admire Mr Trump, especially for his business acumen. Mr Xi, understandably, may view the new US President in a harsher light. Xi faces cascading complexities as well as factional opposition within China. He could most use a US leader cast in the previous mold, committed to constructive cooperation with China. Instead, he’s likely to contend with an unpredictable, disapproving and distrustful adversary.

https://www.ft.com/content/b1801637-4219-3222-9f45-658740aa1187

CICC eyes return to greatness — IFR Asia

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China International Capital Corp has unveiled its much-anticipated acquisition of unlisted China Investment Securities, in a move that may see the PRC’s oldest investment bank regain the top spot in the country’s securities industry.

CICC said on November 4 it planned to acquire 100% of Shenzhen-based CIS for Rmb16.7bn (US$2.47bn) through the issuance of 1.68bn domestic shares to current owner Central Huijin Investment at Rmb9.95 each. The issuance price represents a discount of 0.6% to CICC’s closing prior to the announcement of the proposed acquisition.

The move marks a significant shift in strategy for CICC, which has long flirted with the idea of setting up a retail brokerage unit as its share of business has dwindled, but has so far remained wedded to its institutional clients.

“If you look at CICC’s business model, it has a very strong institutional focus, but we all know China’s capital markets are primarily driven by retail investors,” said Benjamin Quinlan, chief executive officer and managing partner at Quinlan & Associates. “CIS has a strong retail franchise, so it seems to complement CICC’s existing business quite well.”

CICC made its reputation bringing some of China’s biggest state-owned enterprises and red chips to the equity and debt markets. This included the US$21.9bn IPO of Industrial and Commercial Bank of China in 2006 and the US$22bn IPO of Agricultural Bank of China four years later.

After being ranked the number one brokerage firm in China in 2010, it fell to number 23 last year, according to Securities Association of China data, as the flow of giant SOE listings dried up and other Chinese securities firms expanded rapidly, using their stronger capital bases and wider branch networks to build intermediary businesses, especially around margin trading.

Bi Mingjian, appointed CEO of CICC last December, has made expanding the bank’s brokerage and asset management units a key part of his overall strategy and has sought to reduce reliance on institutional and wealthy clients.

CICC has only 20 branches in the PRC versus the 200 of CIS, according to its website. CICC’s small retail footprint has affected its earning capacity from retail investors, who account for most of the trading in the onshore capital markets.

“CICC was originally founded to be China’s one ready-for-Wall Street, global investment bank, but that strategy is no longer perfectly aligned with the profits and priorities of China’s banking industry,” said Peter Fuhrman, chairman and CEO at China First Capital.

“Instead of trying to compete with Goldman Sachs and Morgan Stanley, CICC will now be matched against a group of domestic competitors. This is ideal as investment banking fees within China, both for IPOs and the secondary market, are high and not that troublesome to earn.”

ADVISORY BUSINESS

Most analysts consider the acquisition, at around 1.1 times forward book value, as good value and a good strategic fit that should help propel CICC up the league tables.

“If you aggregate the market share of both firms across the equity and debt capital markets and M&A advisory, the combined entity could come out as number one in all three rankings,” said Quinlan.

“This might not be the case, but we expect CICC to be at least a top-five player in ECM and DCM, following the acquisition, and most probably top three for M&A advisory.”

The proposed acquisition will boost CICC’s balance sheet. CICC ranked 24 in terms of total assets in 2015 with Rmb63bn, while CIS was 18th with Rmb92bn. Their ranking would advance to 13 after the integration, still far short of the industry leader Citic Securities with total assets of Rmb484bn.

CICC ranked 23 among China’s 125 securities firms in 2015 in revenue terms, while CIS ranked 17, according to the Securities Association of China.

Some questions have been raised about the potential cultural mismatch between the two firms and there have also been suggestions that the Chinese government may be directing the acquisition as it seeks to improve the sector’s reputation for probity.

China’s securities sector has expanded at a considerable pace in the last few years with the combined asset base of the 125 securities companies operating there increasing fourfold between 2011 and 2015 to Rmb6.4trn and there are few signs that the pace of growth is likely to abate.

“It could be a win-win situation for the two firms, because their business models are very complementary,” said an analyst.

“However, it is also a big challenge for CICC on whether it can generate the synergies it expects, by applying its strengths in high-end services to the huge customer base and network of CIS,” said the analyst.

Following the acquisition, CIS will become a wholly owned subsidiary of CICC, while Huijin’s stake in CICC will increase to 58.7% from 28.6%.

CICC and ABC International are financial advisers for the transaction. The deal requires approval from shareholders and regulators.

China Inc.’s Investment Bank Dives Into Troubled Retail Market — Bloomberg

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China International Capital Corp., the investment bank ex-Premier Zhu Rongji set up two decades ago to help restructure the Chinese economy, is again taking on a role that fits with the government’s agenda.

CICC’s $2.5 billion acquisition of China Investment Securities Corp. will plunge the firm into the retail investor market, a segment it had long shunned because of thin margins and a traditional focus on institutional clients. The deal is part of Chief Executive Officer Bi Mingjian’s push to lessen dependence on volatile investment banking fees.

Yet the transaction also ties in with a key objective of the government, which will become CICC’s largest shareholder as a result of the purchase. Having used CICC to take some of the largest state companies public since the late 1990s, China is now looking for assistance in its quest to reform a retail-driven equities market that’s prone to speculative booms and busts.

In the wake of the latest such episode, a stock market meltdown last year, the government launched an unprecedented crackdown on the securities industry and arrested several high-ranking executives.

“CICC will once again play this civilizing and globalizing role, only with the more far-reaching aim of helping to professionalize the often-shambolic Chinese stock market,” said Peter Fuhrman, chairman of China First Capital, a Shenzhen-based advisory firm. “Its reputation is still unsullied in China, unlike other banks whose leaders have been marched out in handcuffs and whose market practices are widely blamed for the rampant speculative fever that often afflicts China’s domestic capital markets.”

Reforming Role

In announcing the takeover on Friday, CICC hinted at a reforming role by saying the two firms will “work together to improve the quality and efficiency of mass market services” through training and by upgrading technology systems at China Investment Securities’ 192 branches across the country that serve retail clients.

CICC is buying China Investment Securities from state-owned Central Huijin Investment Ltd. It will issue shares to Central Huijin, more than doubling the entity’s stake in CICC to 58.7 percent. CICC had to get a waiver from the Hong Kong Stock Exchange for the transaction, so that Central Huijin’s controlling stake wouldn’t be classified as a reverse takeover.

An additional rationale for the deal is Huijin’s push to consolidate the securities industry by combining institutional and retail brokerage businesses, said Zhang Chunxin, an analyst at CMB International Capital Holdings Corp. She cautioned that “the reform process will be long and gradual.”

China Investment Securities ranked 17th among Chinese securities firms by revenue last year, while CICC was 23rd, according to official data. Bi’s overhaul has the support of the firm’s foreign shareholders, who had already been pushing CICC to diversify into areas such as asset and wealth management, a person with knowledge of the matter said.

Sherry Tan, spokeswoman at CICC, declined to comment.

Shareholder Backing

The combined stakes of CICC’s main foreign backers — private equity firms TPG Capital and KKR & Co., and Singapore sovereign wealth fund GIC Pte — will drop to 15.3 percent as a result of the takeover. However, the foreign firms may buy additional stakes from Central Huijin in future, people familiar with the matter said.

When former premier Zhu Rongji created CICC in 1995, China was launching a shakeup of its state-run industrial sector, leading to the closure of some 60,000 firms and loss of 40 million jobs. Since then, CICC has worked on some of the biggest listings of state enterprises, such as China Construction Bank Corp. and China Mobile Ltd. It was the top adviser on mergers involving Chinese companies in 2014, 2015 and so far this year.

Buying China Investment Securities is a departure from former CEO Levin Zhu’s strategy. The son of the former premier, who ran the firm until two years ago, had long resisted expanding into retail broking, fearing it would erode margins and its differentiation from other Chinese securities firms, according to people familiar with the matter.

Last year’s leverage-fueled equities rally and the subsequent implosion brought worldwide attention to the shortcomings of China’s markets. The government responded with an effort that included enlisting securities firms in supporting the stock market as well as jailing senior brokerage executives for alleged wrongdoing. CICC wasn’t among the firms that took part in the stock-market rescue, but China Investment Securities was.

Market Manias

China’s 114 million individual investors account for the bulk of equities trading. That makes them a hard-to-ignore segment, but also one that tends to be susceptible to market manias. Critics contend that the government’s efforts to restore market calm last year only served to hurt investor confidence further.

The Shanghai Composite Index remains 39 percent below its June 2015 peak. Xiao Gang, who was removed from his post as chairman of China’s securities regulator this year, in January acknowledged loopholes and ineptitude within the regulatory system.

Some analysts aren’t convinced the deal is in CICC’s best interest. The stock fell 2.1 percent on Monday after a trading halt was lifted.

The transaction makes the firm “more like a state-owned company, which could compromise CICC’s corporate governance, operational autonomy” and its ability to retain top talent, said Fred Hu, Goldman Sachs Group Inc.’s former Greater China chairman.

http://www.bloomberg.com/news/articles/2016-11-07/china-inc-s-investment-bank-dives-into-troubled-retail-market

Has Yum Worked Out How Fast-Food Firms Can Crack China? — Bloomberg

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Global consumer companies trying to find a business model for China’s burgeoning domestic market will be watching closely as one of the oldest Western brands in the country starts a new strategy.

Yum! Brands Inc., which opened its first KFC restaurant in China in 1987 and also operates Pizza Hut outlets, has been losing market share thanks to a food-safety scare, changing tastes, increasing local competition and a host of other challenges that foreign companies face in China. It carved out its China operations into a separate company, Yum China Holdings Inc., which begins trading today in New York.

Ring-fencing the business, the largest independent restaurant company in China with 7,000 outlets and more than $900 million cash on hand, offers Yum a number of advantages in dealing with a fast-changing market. Yum’s example could provide a road map for other global consumer brands in the world’s most populous nation.

Yum China has issued 386 million shares at $24.36, which puts its valuation at around $9 billion, according to New Jersey-based research firm Edge Consulting Group LLC. The stock rose about 2 percent to $24.85 as of 9:59 a.m. in New York, while Yum Brands gained 0.7 percent to $62.49.

“When their China operations get so big and are clearly catering just to the China market, splitting off could unlock a lot of value for shareholders,” said Shaun Rein, Shanghai-based managing director of China Market Research Group. “If I were an activist hedge fund investor, I would be looking at carving out brands within large conglomerates that are China plays.”

Doing so allows Yum’s management of the China business to tailor its operations and products more swiftly to changing local conditions, such as the menu preferences of diners in different parts of the country, mobile-based payments systems, hiring and other factors.

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It also helps tap Chinese investors willing to pay high premiums for a stake of an international brand’s China operations. Yum sold a combined $460 million stake in its Chinese business to Primavera Capital Group and an Alibaba Group Holding Ltd. affiliate, Ant Financial Services Group, in September.

In recent years, Yum has ceded market share to local competitors because it was slow to react to market changes, said Rein.

“They didn’t make corporate decisions quickly enough, such as in adopting mobile payments, or adapting to consumers wanting more premium offerings,” Rein said. “Their ability to deal with the more complex environment here was held back by the lack of knowledge, the slowness of the U.S.”

Localization of offerings at KFC and Pizza Hut outlets in China will be an important component of the firm’s strategy for the country, Yum China Chief Executive Officer Micky Pant said at a briefing Tuesday in Shanghai. The company plans to increase investment in new outlets across its brands and does not plan to raise more capital, he said.

An activist hedge fund investor upset with the company’s handling of its China business is how Yum China came into being.

After a food-safety scandal in 2014 and cheaper local competition torpedoed Yum’s sales and profit in China, Corvex Management founder Keith Meister in mid-2015 urged the company to split off its Chinese operations — which contribute about half the group sales — saying that the move could generate an additional $16 a share in value for the Louisville, Kentucky-based company.

Yum’s total share of China’s market for fast-food chains dropped to 30 percent last year, from 40 percent in 2012, according to data from Euromonitor International. While sales have been growing again in China in the mid-single digits since late last year, the company has suffered from consumers shifting to healthier options and domestic chains sprouting up with more variety.


Volatility Reduction

Unlike Yum’s U.S. operations, where most of its restaurants are run by franchisees, Yum China directly operates over 90 percent of its outlets and plans to triple the number to more than 20,000 in the long term.

Yum’s spinoff would reduce volatility for its remaining business, while “giving investors with a higher risk tolerance access to a more pure-play China growth story,” said Jonathan Morgan, an analyst for Edge Consulting. “China’s economic slowdown could induce other U.S.-listed restaurant stocks to spin off their China businesses, to protect their core businesses.”

So far, companies with China consumer arms have often chosen instead to sell the division to a local competitor and take a stake in that business instead.

Wal-Mart Stores Inc. in June sold its e-commerce platform Yihaodian to China’s second-largest e-commerce company, JD.com Inc., for a 5 percent stake in JD. In August, Uber Technologies Inc. surrendered after a year-and-a-half battle with Didi Chuxing and agreed to sell its business in China. It departed the country in exchange for $1 billion in cash and a 17.7 percent stake in Didi.

McDonald’s Corp., meanwhile, is seeking to sell its 20-year mass franchise rights for China and Hong Kong for a reported $2 billion.

Starbucks Corp. is the only other major U.S.-listed food and beverage chain in China beside Yum, which owns and operates its outlets, numbering 2,400 stores across 110 cities.

China, Starbucks’ largest international market, represents the most significant opportunity for the company, said a company representative. The company has no intention to change its operation model in the market, according to the spokesperson.

Jackpot Valuations

“What we’ve seen across various industries is that foreign players eventually pull out or find a local partner,” said Hong Kong-based S&P Global Ratings’ restaurant and retail analyst Shalynn Teo. “It’s the local market knowledge and local relationships that determine which foreign businesses survive in China, and local players will always have an edge.”

With Chinese investors paying a premium for market share, such deals can prove attractive, said Peter Fuhrman, CEO of Shenzhen-based investment bank and advisory firm China First Capital. “As long as Chinese investors are offering jackpot valuations,

Those that don’t face the need to tailor their businesses to China’s widely diverse and morphing consumer market. Only from March this year did KFCs in China began accepting WeChat Pay; they started accepting Alipay mobile payments in July last year. Yet the country leads the world in the use of such transactions, with four out of 10 Chinese consumers using mobile payments at physical stores, research firm EMarketer estimated.

Starbucks stores in China still do not accept Alipay or WeChat, only Apple Pay, a decision which costs them 5 to 10 percent of sales, estimates China Market Research Group’s Rein.

Starbucks launched its own mobile payment system in China in July, allowing customers to pay with preloaded Starbucks Gift Cards via their mobile devices, according to the company.

As China’s consumer market continues to grow, more overseas companies may consider following Yum down the path of segregation.

“Four out of 10 spinoffs do not generate a return in the first year of separation,” said Edge Consulting’s Morgan. “How Yum China performs will help U.S.-listed companies evaluate their strategic options in China.”

 

http://www.bloomberg.com/news/articles/2016-10-31/yum-s-spinoff-offers-roadmap-for-western-brands-in-china-market

Quietly But Successfully, US Companies Are Buying Chinese Businesses

--FILE--RMB (renminbi) yuan and US dollar bills are pictured at a bank in Huaibei city, east Chinas Anhui province, 16 September 2011. Chinas yuan edged down versus the dollar on Tuesday (11 October 2011), consolidating its biggest single-day gain a day earlier, brushing aside a record central bank mid-point as US lawmakers prepare to vote on a bill aimed at punishing Beijing for alleged currency manipulation. The Peoples Bank of China, the countrys central bank, set the yuan central parity rate at 6.3483 against the dollar, compared with 6.3586 on Monday.

Is China really buying up America? Or is it the opposite?

Chinese investments in the US draw lots of headlines and occasional handwringing about China’s growing influence and ownership. It is true that Chinese investors, especially SOE, have been throwing billions of dollars around, mostly for US real estate.

Far more quietly, and perhaps with better overall results, US investors have been buying businesses in China. The US acquirers do their utmost to stay out of the headlines. They prefer to shop quietly, without competitors finding out. This does a lot to keep prices down and give these US buyers maximum negotiating leverage. A lot of these US acquisitions in China stay secret long after they close.

Contrast this style with that of Chinese investors in the US. Most end up bidding against one another for the same assets. Overpaying has become a hallmark of Chinese purchases in the US.

Compared to the huge number of Chinese companies shopping for assets in the US, not nearly as many US companies are sizing up deals and kicking tires in China. Partly this stems from some misunderstandings among less-experienced US acquirers about what kinds of Chinese businesses can be targeted. Topping the list of sweeping generalizations: Chinese companies, especially privately-owned ones, are said to have owners who rarely wish to sell. Those that do, want to sell their deeply troubled companies at Neiman Marcus prices.

There is some truth to this arm-chair analysis. But, equally, there are good deals being done. I’ve written before about the most successful US acquisition in China, by food giant General Mills. (Click here to read.) It’s a textbook case of how to do M&A in China and also how to build a billion dollar business there without anyone really noticing.

Why buy rather than build in China? For one thing, China has huge and fast-growing markets in almost all industries except the smoke-stack ones. For buyers that choose and execute well, the China market is proving lucrative ground to do M&A. It’s a truth that remains a known to a select group of smart buyers.

Lifting the veil a bit, here are some of the largely-unpublicized acquisitions done by smart American buyers in China.

3d

In April 2015, 3D Systems, a New York Stock Exchange-quoted manufacturer of 3D printers, purchased 65% of a Chinese 3D printing sales and service company Wuxi Easyway. The Chinese company’s customers in China include VW, Nissan, Philips, Omron, Black & Decker, Panasonic and Honeywell. 3D Systems has an option to purchase the remainder of the business within five years.

Along with acquiring a developed sales network and increased distribution in China, another key aspect of the deal was to make the founder of Easyway, a Western-educated Chinese, the CEO of a newly-formed subsidiary,  3D Systems China.  The plan is to make the Chinese founder the king of a larger kingdom, a carrot frequently dangled by American companies to persuade Chinese founders to sell to them.

Since the deal closed, 3D Systems also accelerated the build-out of its operational infrastructure in China. What lies behind the deal? 3D Systems acquired a local management team as well sales channels, customer relationships.  It did not acquire manufacturing capability.

3D Systems manufactures high-quality 3D printers that sells at significantly higher prices than Chinese domestic competitors. Owning a Chinese business with established customer relationships in China will make it easier for 3D Systems to penetrate more deeply what should become the world’s largest market for 3D printers. The shift is particularly strong among Chinese private sector manufacturing companies making products for China’s consumer market.

Prior to the acquisition, Easyway was not a major client or partner of 3D Systems. As the integration moves forward, Easyway will likely expand its product offerings in China beyond relatively commoditized business of producing 3D prototypes. 3D Systems’ printers have broader capabilities, including the production of end-use parts, molds for advanced tool production, medical and surgical supplies.

The dual-track strategy is for Easyway to maintain its existing comparatively low-end service business in China while adding two new sources of revenue: the sale of 3D Systems’ 3D printers in China and an enhanced/upgraded service business of using 3D Systems printers to produce higher-quality and more complex parts to order for Chinese customers.  Both should positively impact 3D Systems’ P&L.

3D Systems used a deal structure that often works well in China. They bought a majority of Easyway, while leaving the target company founder/owner with a 35% minority stake in an illiquid subsidiary of 3D Systems. 3D Systems has the option to buy out the remaining shares and assume 100% control. But, the option may never be exercised. 3D Systems now enjoys the benefits of holding corporate control, including consolidation, while also keeping the previous owner aligned and incentivized.

The deal isn’t without its risks, of course. 3D Systems previously had no corporate presence in China. It therefore did not have its own management team in place and on-the-ground in China to manage the integration of Easyway and monitor the business going forward.

illinois

In July 2013, Illinois Tool Works (“ITW”), a huge and hugely-successful US industrial conglomerate, purchased 100% of a Chinese kitchen supply manufacturer Gold Pattern Holdings, based in Guangzhou, from global private equity firm Actis.

The acquisition fits well with the expansion strategy of ITW of looking to make tuck-in acquisitions in their core business segments. ITW has a large food equipment business with over $2 billion in annual revenue, 15% of ITW’s total.  Gold Pattern’s business is selling Western-style kitchen equipment to restaurants and hotels in China.

From discussions we’ve had with ITW since the acquisition, the deal is considered a solid success within ITW. The company says it has a strengthened appetite to make more such acquisitions in China, a key market for the company going forward.

ITW owns some of the most well-known brands in the food equipment industry, including Hobart mixers and Vulcan ranges. Buying Gold Pattern was part of a strategy to increase sales and distribution of these ITW brands in the fast-growing China market. Gold Pattern’s own commercial kitchen equipment is lower-priced and generally considered lower-quality.  But, the domestic sales channels used to sell Gold Pattern’s equipment is also suitable to distribute ITW’s US brands.

ITW expects that as China continues to grow more affluent, the demand among the Chinese middle class for European and American food will expand significantly. This will create a long-term market opportunity for ITW to sell Western style commercial kitchen equipment. More and more four-and-five star hotels in China are being equipped with Western kitchens as well as Chinese ones.

ITW mitigated its deal risk by buying Gold Pattern from a well-regarded international PE fund. As a result, Gold Pattern already had fully-compliant GAAP accounting, established corporate governance structures, and a professional management team. No less important, ITW knew from the outset that Gold Pattern had already successfully undergone the forensic due diligence process that preceded Actis buying control of the company. This significantly lower due diligence risk, a prime reason many deals in China – both minority and control – fail to close.

ITW has significant experience buying and integrating businesses globally. They had operations in China for twenty years prior to this acquisition.  ITW and another diversified Midwestern industrial company, Dover Corporation, are both actively, but ever-so-quietly seeking more acquisitions in China, aimed primarily at expanding their sales and distribution in China’s growing domestic market.

 amazon

This deal happened a long time ago, but continues to pay dividends for Amazon. In August 2004, they bought 100% of Chinese e-commerce company Joyo, paying a total of $75mn including an earn-out.  At the time, e-commerce in China was in its infancy, while Amazon was less than one-tenth its current size. The purchase of Joyo was a calculated gamble that China’s online shopping industry, despite huge impediments at the time including no established online payment systems would eventually achieve meaningful scale.

The gamble has paid off handsomely for Amazon. The e-commerce industry in China is now at least 50X larger than in 2004, with revenues last year of over $700bn. E-commerce revenues are projected to double in China by 2020. Amazon is the only non-Chinese company with meaningful market share and revenues in this hot sector. That said, Amazon is dwarfed by Alibaba’s Taobao, which has a market share in China estimated at 75%.

But, Amazon in 2012 spotted an opportunity to use its China-based business to establish a highly-lucrative cross-border business facilitating direct export sales by Chinese manufacturers and individual traders on Amazon’s main US and UK websites.  This is a business Alibaba has tried and so far failed to enter.  As a result, Amazon’s senior management, if they know no one is listening, will tell you the Joyo acquisition is a big success. It generates meaningful revenue in China (approx. $3bn), while supporting the infrastructure to build out the cross-border exports.  Amazon continues to invest aggressively in China, with enormous warehouse facilities (800,000 total sqm) and wholly-owned logistics business.

When Amazon bought Joyo, it knew full well that Chinese law, as written, forbids foreign companies from owning a domestic internet company. The Chinese government views the internet and e-commerce as “strategic national industries”. At the time, Amazon got around this by using an ownership structure for its China business called a “Variable Interest Entity” (“VIE”) also used by some domestic Chinese e-commerce companies that listed on the US stock market. The Chinese government, if they chose to, could probably shut Amazon down in China, because it’s using this loophole to operate in China. That could leave Amazon scrambling to find a way to stay in business in a country in which it now has hundreds of millions of dollars in assets.

The boards of many other large US companies would blanch at approving a deal where the assets are owned indirectly and control could be so easily forfeited by Chinese regulatory action. But, Amazon, with founder Jeff Bezos firmly in control, has shown itself time and again to be comfortable with making rather bold bets. Success in China often requires that mindset.

negative

Of course, US buyers have also slipped on their share of Chinese banana peels. Three well-known Silicon Valley technology companies tried and mainly failed to do M&A successfully in China. All three followed a similar strategy to acquire domestic Chinese technology companies started and owned by Chinese who had previously studied and worked in the tech field in the US. The acquisitions followed the general strategic logic of most tech M&A within the US: to identify and acquire companies with complimentary proprietary IP. But, the results in China fell well short of expectations.

The three deals were:

  1. Cirrus Logic acquired Caretta Integrated Circuits in 2007. By 2008, the acquired company was shut down and Cirrus recorded a $12mn loss.
  2. Netgear acquired CP Secure in 2008. There is now no trace of the original CP Secure business, nor any indication it is ongoing concern.
  3. Aruba Networks acquired Azalea Networks in 2010, a Chinese wireless LAN provider.

Over the last five years, no similar M&A deals in China were announced by larger Silicon Valley companies. The strategy has shifted from acquiring companies for their IP to targeting companies for their domestic Chinese distribution and sales channels.  This reflects the fact that indigenous innovation in China has not made much of a global impact. IP protection in China is still inadequate by US standards. China is also a late adopter market, which further impedes the development of globally-competitive domestic technology companies.

The successful US acquisitions in China were all rooted in a different, more viable strategy: to buy one’s way directly or indirectly into China’s burgeoning consumer market.

chart

Abridged version as published in Nikkei Asian Review

Chinese Firms Are Reinventing Private Equity — Nikkei Asian Review

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Pudong

July 26, 2016  Commentary

Chinese firms are reinventing private equity

Henry Kravis, his cousin George Roberts and his mentor Jerry Kohlberg are generally credited with having invented private equity buyouts after forming KKR 40 years ago. Even after other firms like Blackstone and Carlyle piled in and deals reached mammoth scale, the rules of the buyout game changed little: Select an underperforming company, buy it with lots of borrowed money, cut costs and kick it into shape, then sell out at a big markup, either in an initial public offering or to a strategic buyer.

This has proved a lucrative business that lots of small private equity firms worldwide have sought to copy. China’s domestic buyout funds, however, are trying to reinvent the PE buyout in ways that Kravis would barely recognize. Instead of using fancy financial engineering, leverage and tight operational efficiencies to earn a return, the Chinese firms are counting on Chinese consumers to turn their buyout deals into moneymakers.

Compared to KKR and other global giants, Chinese buyout firms are tiny, new to the game and little known inside China or out. Firms such as AGIC, Golden Brick, PAG, JAC and Hua Capital have billions of dollars at their disposal to buy international companies. Within the last year, these five have successfully led deals to acquire large technology and computer hardware companies in the U.S. and Europe, including the makers of Lexmark printers, OmniVision semiconductors and the Opera web browser.

So what’s up here? The Chinese government is urgently seeking to upgrade the country’s manufacturing and technology base. The goal is to sustain manufacturing profits as domestic costs rise and sales slow worldwide for made-in-China industrial products. The government is pouring money into supporting more research and development. It is also spreading its bets by providing encouragement and sometimes cash to Chinese investment companies to buy U.S. and European companies with global brands and valuable intellectual property.

While the hope is that acquired companies will help China move out of the basement of the global supply chain, the buyout funds have a more immediate goal in sight, namely a huge expansion of the acquired companies’ sales within China.

This is where the Chinese buyout firms differ so fundamentally from their global counterparts. They aren’t focusing much on streamlining acquired operations, shaving costs and improving margins. Instead, they plan to leave things more or less unchanged at each target company’s headquarters while seeking to bolt on a major new source of revenues that was either ignored or poorly managed.

So for example, now that the Lexmark printer business is Chinese-owned, the plan will be to push growth in China and capture market share from domestic manufacturers that lack a well-known global brand and proprietary technologies. With OmniVision Technologies, the plan will be to aggressively build sales to China’s domestic mobile phone producers such as Huawei Technologies, Oppo Electronics and Xiaomi.

The China Android phone market is the biggest in the world.  Omnivision used to be the main supplier of mobile phone camera sensor chips to the Apple iPhone, but lost much of the business to Sony.

In launching last year the $1.8bn takeover of then then Nasdaq-quoted Omnivision, Hua Capital took on significant and unhedgeable risk. The deal needed the approval of the US Committee for Foreign Investment in the United States, also known as CFIUS. This somewhat-shadowy interagency body vets foreign takeovers of US companies to decide if US national security might be compromised. CFIUS has occasionally blocked deals by Chinese acquirers where the target had patents and other know-how that might potentially have non-civilian applications.

CFIUS also arrogates to itself approval rights over takeovers by Chinese companies of non-US businesses, if the target has some presence in the US. It used this justification to block the $2.8 billion takeover by Chinese buyout fund GO Scale Capital of 80% of the LED business of Netherlands-based Philips. CFIUS acted almost a year after GO Scale and Philips first agreed to the deal. All the time and money spent by GO Scale with US and Dutch lawyers, consultants and accountants to conclude the deal went down the drain. CFIUS rulings cannot be readily appealed.

Worrying about CFIUS approval isn’t something KKR or Blackstone need do, but it’s a core part of the workload at Chinese buyout funds. Hua Capital ultimately got the okay to buy Omnivision five months after announcing the deal to the US stock exchange.

The Chinese buyout firms see their role as encouraging and assisting acquired companies to build their business in China. This often boils down to business development and market access consulting. Global buyout firms say they also do some similar work on behalf of acquired companies, but it is never their primary strategy for making a buyout financially successful.

Chinese buyout funds count on two things happening to make a decent return on their overseas deals. First is a boost in revenues and profits from China. Second, the funds have to sell down their stake for a higher price than they paid. The favored route on paper has been to seek an IPO in China where valuations can be the highest in the world. This path always had its complications since it generally required a minimum three-year waiting period before submitting an application to join what is now a 900-company-long IPO waiting list.

The IPO route has gotten far more difficult this year. The Chinese government delivered a one-two punch, first scrapping its previous plan to open a new stock exchange board in Shanghai for Chinese-owned international companies, then moving to shut down backdoor market listings through reverse mergers.

The main hope for buyout funds seeking deal exits now is to sell to Chinese listed companies. In some cases, the buyout funds have enlisted such companies from the start as minority partners in their company takeovers. This isn’t a deal structure one commonly runs across outside China, but may prove a brilliant strategy to prepare for eventual exits.

There is one other important way in which the new Chinese buyout funds differ from their global peers. They don’t know the meaning of the term “hostile takeover.” Chinese buyout funds seek to position themselves as loyal friends and generous partners of a business’s current owners. A lot of sellers, especially among family-controlled companies in Europe, say they prefer to sell to a gentle pair of hands — someone who promises to build on rather than gut what they have put together. Chinese buyout funds sing precisely this soothing tune, opening up some deal-making opportunities that may be closed to KKR, Blackstone, Carlyle and other global buyout giants.

The global firms are also finding it harder to compete with Chinese buyout funds for deals within China, even though they have raised more than $10 billion in new funds over the last six years to put into investments in the country. They have basically been shut out of the game lately because they can’t and won’t bid up valuations to the levels to which domestic funds are willing to go.

The global buyout giants won’t be too concerned that they face an existential threat from their new Chinese competitors. It is also unlikely that they will adopt similar deal strategies. Instead, they are getting busy now prettying up companies they have previously bought in the U.S. and Europe. They will hope to sell some to Chinese buyers. Along with offering genial negotiations and a big potential market in China, the Chinese buyout funds are also gaining renown for paying large premiums on every deal. No one ever said that about Henry Kravis.

Peter Fuhrman is the founder, chairman and CEO of China First Capital, an investment bank based in Shenzhen.

Abridged version as published in Nikkei Asian Review

China to fine-tune back-door listing policies for US-listed companies — South China Morning Post

 

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China reverse mergers

Mainland China’s securities regulator will fine-tune policies related to back-door listing (reverse merger)attempts by US-listed Chinese companies, industry insiders say, but it is unlikely to ban them or impose other rigid restrictions.

“It is clear that the regulator does not like the recent speculation on the A-share markets triggered by the relisting trend and will do something to curb such conduct, but it seems impossible they would shut good-quality companies out of the domestic market,” Wang Yansong, a senior investment banker based in Shenzhen, said.

The China Securities Regulatory Commission (CSRC) was considering capping valuation multiples for companies seeking relisting on the A-share market after delisting from the US market, Bloomberg reported on Tuesday. Another option being discussed was introducing a quota to limit the number of reverse mergers each year from companies formerly listed on a foreign bourse.

To curb speculation, it is most important to show the authorities have clear and strict standards for approving these deals
Wang Yansong.

However, Wang said the CSRC was more likely to strengthen verification of back-door listing deals on a case-by-case basis.

“To curb speculation, it is most important to show the authorities have clear and strict standards for approving these deals, and won’t allow poor-quality companies to seek premiums through this process,” she said.

US-listed mainland companies have been flocking to relist on the A-share market since early last year, when the domestic market started a bull run, in order to shed depressed valuations in American markets.

The valuations of relisted companies have boomed, and that has triggered a surge in speculation on possible shell companies – poorly performing firms listed on the Shanghai or Shenzhen bourses. In a process called a reverse takeover or back-door listing, a shell can buy a bigger, privately held company through a share exchange that gives the private company’s shareholders control of the merged entity.

The biggest such deal was done by digital advertising company Focus Media. Its valuation jumped more than eightfold to US$7.2 billion after it delisted from America’s Nasdaq in 2013 and relisted in Shenzhen in December last year, with private equity funds involved in the deal reaping lucrative returns.

Peter Fuhrman, chairman of China First Capital, an investment bank and advisory firm, said the trend of delisting and relisting was “one of the biggest wealth transfers ever from China to the US”.

“The money spent by Chinese investors to privatise Chinese companies in New York ended up lining the pockets of rich institutional investors and arbitrageurs in the US,” he said.

However, a tightening or freeze on approval of such deals would threaten not only US-listed Chinese companies in the process of buyouts and shell companies, but also the buyout capital sunk into delistings and relistings.

“The more than US$80 billion of capital spent in the ‘delist-relist’ deals is perhaps the biggest unhedged bet made in recent private equity history … if, as seems true, the route to exit via back-door listing may be bolted shut, this investment strategy could turn into one of the bigger losers of recent times,” he said.

On Friday, CSRC spokesman Zhang Xiaojun sidestepped a question about a rumoured ban on reverse takeover deals by US-listed Chinese companies in the A-share market, saying it had noticed the great price difference in the domestic and the US markets, and the speculation on shell companies, and was studying their influences.

http://www.scmp.com/business/markets/article/1943386/china-fine-tune-back-door-listing-policies-us-listed-companies

For article on a related topic published in “The Deal”, please click here